Why I'm Buying GameStop And Why You Should Too

| About: GameStop Corp. (GME)

Summary

GameStop has had lots of negative press lately and negative sentiment is high.

This has led to an attractive valuation with a high margin of safety.

Near-term catalysts exist to propel GameStop back to fair value.

There has been much negative press written about GameStop (NYSE:GME) lately on Seeking Alpha, and perhaps rightly so - sales have declined throughout 2016 and holiday sales were abysmal.

Shortly after the pre-market release of the holiday sales, the stock went on to drop by 9%.

Obviously, many investors are running for the hills given the declining sales. Some have gone on as to declare GameStop as the next Blockbuster or RadioShack (NYSE:RSH).

Now, many of you reading this are very familiar with GameStop and I don't need to reinvent the wheel and waste your time discussing the business model and the inherent risks - many Seeking Alpha article contributors have already done so (see here, here and here)

Instead, I would like to use these words to cut through the doom and gloom and discuss why I think today is a great opportunity to invest in GameStop.

Exhibit A: An Exceptionally Compelling Valuation

Be greedy when others are fearful, and fearful when others are greedy"

- Warren Buffett

Fear about the declining sales has led to a dramatic depression in share prices. Trading in the low $20s, today's prices represent a ridiculous discount on intrinsic value. Based on Capital IQ analyst expectations for the next five years, fair value is about $70. One would literally more than triple their money if GameStop reaches fair value. The sooner this happens, the higher the annualized rate of return. Indeed, near-term catalysts exist (see below) that I think will return GameStop to fair value.

Even if analysts grossly overestimate the future cash flow, there is still a high possibility for a double.

Don't believe in analyst expectations? Well, with a current P/E of 6 you get an earnings yield of 16.6%.

Lies, damned lies, and financial statements"

- Anonymous

Think earnings reports are the alchemy of corporate accountants? Well, with a current P/FCF of 5.3 you're getting a free cash flow yield of 18.8%.

No matter how you slice it, GameStop is cheap. This creates a high margin of safety.

Furthermore, because share prices are so depressed, the dividend yield is very attractive (north of 6% at the time of writing). The payout ratio is also only 40%, so in the short term a cut is very unlikely. Not only is GameStop cheap, but you get handsomely compensated to just hold your shares.

Exhibit B: A Near-Term Catalyst

The Microsoft (MSFT) Xbox One and Sony (SNE) PlayStation 4 (PS4) were both released in 2013. Since then, there have been no major console releases. 2017 is set to be a year of major releases, with the Nintendo (OTCPK:NTDOY) Switch coming in the spring and then the Xbox Two presumed to be released for the holiday season of 2017. The Sony PlayStation 5 (PS5) is presumed to be released in 2018 or 2019.

With new consoles come new games that should drive sales. One common counterpoint floated is that with the rise of internet speeds, middle men retailers (like GameStop) are being cut out by the publishers, as they can directly release their games to the consumers for direct download.

This is a reasonable counter point; however, there is one major limitation - that's the internet speed itself. At present, large Xbox One games are 40-50 gigabytes (gb). Being 4k ready, it would be feasible for an Xbox Two game to be 200+ gb, especially considering there is likely to be a virtual reality component to the new set.

Present internet infrastructure allows most consumers access to speeds at about 100 megabytes per second (mbps). At 100 mbps, a 200gb game would take about two and a half hours to download. Now, this assumes a best-case scenario. On the day of a hot release, with all gamers accessing the same server at the same time to download the same game, is it likely that a 100 mbps speed will be realized? What if it isn't? Lots of headache, heartache and frustration would ensue. Thus, if I was a gamer, I'd just drive to my local GameStop and buy the game in person, knowing I have a physical copy to take home and play immediately.

Summary:

The intelligent investor is a realist who sells to optimists and buys from pessimists"

- Benjamin Graham

It's fairly easy to see there is great pessimism about GameStop which has driven down the share price. I believe this has created a massive disconnect between price and value, and at today's prices there is a very attractive margin of safety.

I also believe the near-term catalysts - the soon to be released Nintendo Switch and the upcoming release of the Xbox Two and PS5 - will push GameStop back to its full value.

This is why I am buying GameStop and will continue to do so anytime there is a substantial dip.

What do you think about GameStop? Please feel free to let me know in the comments section below. Thanks for reading!

Disclosure: I am/we are long GME.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not an investment professional and I advise you do your own due diligence on any of the stocks discussed above.

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